CFA Level I · CFA Level I Exam · Capital Structure
Compared with a firm with stable cash flows and mostly tangible assets, a firm with volatile cash flows and mostly intangible assets is most likely to have:
The firm with volatile cash flows and intangible assets most likely has a lower optimal debt ratio. Its higher probability of distress and larger value loss in liquidation raise expected distress costs at any leverage level, so they offset the tax shield benefit at a lower debt level.
- AA higher optimal debt ratio under static trade-off theory.
- BThe same optimal debt ratio because tax rates are identical.
- CA lower optimal debt ratio under static trade-off theory.Correct
Explanation
Volatile cash flows raise the probability of distress, and intangible assets lose more value in liquidation. Both raise expected distress costs, so the marginal cost curve rises sooner and the optimal debt ratio is lower.
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